Introduction to Cash Flow Statement - Cash flow statements, Cost Accounting - B Com PDF Download

Introduction  

The cash flow statement is one of the three key financial statements, detailing cash and cash equivalent movements over a specific period. It is highly valued by financial information users as it helps assess a company’s financial strength and long-term prospects. This statement considers various business activities and highlights historical changes in cash and cash equivalents by categorizing cash flows into operating, investing, and financing activities. As per the revised Accounting Standard-3 (AS-3), all listed companies must prepare and present an annual cash flow statement alongside other financial reports.

This unit discusses and explains the method of preparing a cash flow statement for an accounting period. 

Features of Cash Flow Statement Cash Flow Statement 

Features are mentioned as follows: 

1. A cash flow statement is a periodic statement. 
2. It is a statement of change in the financial position on a cash basis.
3. It shows the movement of cash and explains the reasons for changes in cash position between two balance sheet dates. 
4. It does not match cost against revenue. 
5. It shows the inflow and outflow of cash and cash equivalents from various activities. 
6. It helps assess the company’s capability to generate cash and cash equivalents and channels to utilise those cash flows. 
7. It provides information on inflow and outflow of cash and cash equivalents from various activities of a company under various heads, i.e. operating, investing and financing activities. 

Preparation of Cash Flow Statement 

Following basic documents or data are required to prepare the statement: 

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Objectives and Benefits of Cash Flow Statement 

Objectives of Cash Flow Statement The objectives of the cash flow statement are as follows: 

• To make future financial policies. 
• To identify the extent of major expenses. 
• To devise the cash requirement for a period. 
• To find reasons for the net cash inflows or outflows.
• To predict the financial strength of the company. 

Benefits of Cash Flow 

Highlights liquidity position

• Liquidity refers to the ability to settle obligations on time or as they become due.
• A cash flow statement helps assess the liquidity position of a business.
• It reflects the cash position and provides insights into cash payments made during business operations, confirming the company's liquidity status.

Helps in cash management

• A cash flow statement plays a crucial role in managing cash flow effectively.
• It enables companies to estimate expected future cash inflows and outflows.
• By using this statement, businesses can plan their financial strategies efficiently while maintaining liquidity.

Maintain optimal cash balance

• Another advantage of a cash flow statement is that it helps businesses maintain an appropriate cash balance.
• It allows companies to identify idle, excessive, or insufficient cash levels.
• Once the required cash position is determined, companies can either invest surplus cash or secure additional funds if there is a shortfall.

Comparability

• The cash flow statement allows for an accurate comparison of cash-based performance among different companies.
• It ensures consistency in accounting treatments for similar transactions and events.
• Businesses can align their cash flows with industry standards or adjust them based on leading competitors' financial structures.

Indicates future

• A key benefit of the cash flow statement is that historical cash flow data serves as a reliable predictor of future cash flows.
• Information about past cash amounts, timing, and reliability can be used to forecast future cash movements.
• It also helps verify the accuracy of previous cash flow predictions.

Cash and Cash Equivalents 

Cash and Cash Equivalents As per AS-3¹, Cash comprises cash in hand and demand deposits with banks. Cash equivalents means short-term highly liquid investments that are readily convertible into known amounts of cash and subject to an insignificant risk of changes in value. Cash equivalents have the following features: 

• Cash equivalents can be readily converted into cash. 
• These are held to meet short-term cash requirements rather than for investments purposes. 
• Cash equivalents have a short term maturity, normally, three months or less.   
• Cash equivalents are highly liquid and easily sellable in the market. 
• Buyers of cash equivalents are easily accessible.

Marketable securities and money market instruments are considered cash equivalents. Generally, it includes commercial paper, treasury bills, shortterm government bonds etc. with a maturity date of three months or less.

Cash Flows

A company creates value for the shareholders by generating positive cash flows for them. As per AS-3¹, cash flows are inflows and outflows of cash and cash equivalents, i.e. cash flows is the amount of cash and cash equivalents move in and out of a business. Cash flow generated in a company adds to its cash reserves, which further accelerate reinvestment in the company.

Types of Activities and Cash Flow Classification  

As per AS-3¹, these activities can be put into three categories: 

• Operating activities
• Investing activities, and  
• Financing activities  

This classification shows the cash flows generated and used in these activities.  

Cash from Operating Activities 
Operating activities comprised of the primary activities of a company. These activities create the principal revenue stream for the company. Cash flow from operating activities is the first subdivision portrayed on a cash flow statement. Cash from operations is an indicator of the internal solvency of the company. 

• Cash from operating activities signifies the cash a company generates from its ongoing and regular business activities. 
• These activities include routine acts of manufacturing and selling goods or a service to clients.  
• It focuses only on core business activities and does not include non-core, longterm capital expenditures or investment revenues etc.  
• As it considers only the core business, cash flow from operating activities is a yardstick to verify the financial status of a company.

There are two different methods to identify cash from operating activities: the indirect method and the direct method.

Cash Inflows from Operating Activities 

• Cash receipts from the sale of goods and the rendering of services. 
• Cash receipts from royalties, fees, commissions and other revenues. 

Cash Outflows from Operating Activities 

• Cash payments to suppliers for goods and services 
• Cash payments to employees 
• Cash payment on behalf of the employees 
• Cash payments for insurance premiums and claims, annuities, and other benefits. 
• Cash payments or refunds of income taxes  

Non-operating cash flows are clearly different from operating cash flows. For example, non-operating cash flows include taking a loan or issuing new shares and are usually non-recurring. 

Cash from Investing Activities 
As per AS-3, investing activities are the acquisition and disposal of longterm assets and other investments not included in cash equivalents. Investing activities are related to the purchase and sale of long-term or fixed assets of a company. These assets include land and building, machinery, furniture etc. These activities signify the extent to which expenditures are made for acquiring resources to generate future cash flows. Cash flows related to longterm investments are also known as investing activities. 

Cash Inflows from Investing Activities  

• Cash receipt from the disposal of fixed assets, including intangibles assets. 
• Cash receipt from the disposal of intangibles assets. 
• Cash receipt from the repayment of advances or loans made to third parties. 
• Cash receipt from the disposal of shares, warrants or debt instruments of other enterprises other than receipts from those instruments considered as cash or cash equivalents or held for trading purposes. 
• Interest received in cash from loans and advances. 
• Dividend received from investments in other companies. 
• Cash receipts from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing, or trading purposes, or the receipts are classified as financing activities 

Cash Outflows from Investing Activities 

• Cash payments to acquire fixed assets, including intangibles and capitalised research and development. 
• Cash payments to acquire shares warrants or debt instruments of other enterprises other than the instruments considered to be cash equivalents or held for trading purposes. 
• Cash advances and loans made to a third party (other than advances and loans made by a financial enterprise, wherein it is operating activities). 
• cash payments for futures, forward, options and swap contracts except when the contracts are held for dealing or trading purposes, or the payments are classified as financing activities; and   

Cash from Financing Activities 
As per AS-3, financing activities are activities that result in changes in the size and composition of the owners’ capital (including preference share capital in case of a company) and borrowings of the enterprise.  

It is the part of a company’s cash flow statement, which shows the flows of cash used to fund the company that involve equity, debt and dividends. It provides an insight into a company’s financial strength and its capital structure. These activities are related to long-term funds or capital as cash proceeds from issue of equity shares, debentures, bank loans etc. 

Cash Inflows from Financing Activities 

• Cash proceeds from issuing shares or other similar instruments. 
• Cash proceeds from issuing debentures, loans, bonds and other short or long-term borrowings. 

Cash Outflows from Financing Activities 

• Cash repayments of amounts borrowed. 
• Interest paid on loans, debentures and advances. 
• Dividends paid on equity and preference capital. 

Sometimes, one transaction may fall into more than one different Cash Flow Statement classification. For example, the purchase of shares is an operating activity for a share broker, while it is referred to as investing activity for another enterprise. 

Non-cash Transactions 
As per AS-3, investing and financing transactions that do not require the use of cash or cash equivalents should be excluded from a cash flow statement. Examples of such transactions are – acquisition of machinery by the issue of equity shares or redemption of debentures by the issue of equity shares.  

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Preparation of Cash Flow Statement

Basic Structure of the Cash Flow Statement 

The basic structure of the cash flow statement is presented as under: 

Cash Flow from Operating Activities 
The calculation of cash flow from operations is regarded as the most challenging aspect of preparing the statement. As stated earlier, according to AS-3, a company can present these cash flows using either the direct or indirect method. Detailed discussion is given below: 

Direct Method
Under this method, cash receipts and cash payments are arranged and presented in the cash flow statement. The difference between cash receipts and payments is the net cash flow from operating activities. The financial statement provides the summarised data for revenue and expenses. The accrual basis of revenue and expenses are to be converted to equivalent cash receipts and payments. 

Some examples of cash receipts and payments are mentioned as under: 

• Cash receipts from customers/debtors 
• Cash receipts of royalties, fees, commission etc 
• Cash paid to suppliers 
• Cash paid for purchases
• Cash paid for wages and salaries 
• Cash paid for various taxes , interest etc 

Cash receipt from Customers/debtors:  
In an ideal situation where a business operates solely on a cash basis, the sales revenue in the income statement would match the cash received from customers. However, in practice, businesses also engage in credit sales. The outstanding amount is represented by the closing balance of debtors. To determine the cash received from debtors, the opening balance (debtors/bills receivable) is added to the credit sales amount, and the closing balance is then deducted.

Cash Collected from Debtors can also be calculated as follows: 

Cash paid to suppliers / Purchases 
For purchases, cash payments to suppliers consider the cost of goods sold from the Profit & Loss account and others from the Balance Sheet, etc. The calculations are as follows:

Cash Paid to Employees 

The calculation for cash payments is presented as under: 

The following points should be noted:  

• The sale of fixed assets and investments does not require any adjustment here. 
• Bad debts, sales returns, purchases returns, discount allowed, discount received etc. require adjustment. 
• Items like depreciation, amortisation of intangible assets like goodwill, debenture discount, preliminary expenses, premium on redemption of debentures and preference shares are ignored.  
• Non-cash items are omitted from a statement of cash flows.  

Cash Flows from Operating Activities (Direct Method)

Indirect Method

In the indirect method, the net profit/loss forms the base to calculate net cash flow. Non-cash and non-operating charges put in the Profit & Loss account are added back, whereas non-cash and non-operating incomes are deducted to calculate operating profit. Adjustments are further needed in current assets and current liabilities to obtain net cash from operating activities. 

Cash flows from Operating Activities (Indirect Method)​​​​​​

Illustration:
From the following information, calculate the net cash flow from operating activities for the year ended March 31, 2020, using direct method.

Solution: 

​

*Only operating income and expenses are considered. 

Cash Flow Statement 

There is no specific format of cash flow statement in Accounting Standard-3 (Revised). A widely accepted format under direct method and indirect method is being provided below: 

Proforma for Cash Flow Statement (under Direct Method) 

Statement of .................for the period ended................... 

Proforma for Cash Flow Statement (under Indirect Method) 

Statement of .................for the period ended................... 

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Activity : Cash Flow Statement of NTPC Ltd

Cash Flow of three years of NTPC Ltd is produced here. Create a group of your classmates and compare the figures of each year with another year. Further, comment on the increase/decrease of cash flows in various activities. Also, discuss the reasons for such increase/decrease.

Comparative Cash Flow Statement of NTPC Ltd*

Summary 

1. The cash flow statement presents the inflows and outflows of cash and cash equivalents within a specific period.
2. It is highly valued by businesses as it serves as a crucial tool for financial information users, helping them understand the sources and uses of cash over time.
3. A cash flow statement is a periodic financial reportthat highlights changes in a company's cash position.
   • It provides an overview of cash movements between two balance sheet dates.
   • It explains the reasons for fluctuations in cash and cash equivalents.
   • It helps assess a company’s ability to generate and utilize cash efficiently.
4. The cash flow statement categorizes transactionsinto three main activities:

   • Operating Activities: Represent the core business operations that generate revenue.

   • These activities include cash transactions related to the company’s main business functions.

   • There are two methods for determining cash flow from operations:
     (i) Direct method: Reports actual cash receipts and payments.
     (ii) Indirect method: Starts with net income and adjusts for non-cash items.

5. Investing Activities: Include the acquisition and disposal of long-term assets and investments.
   • This category covers cash transactions related to the purchase or sale of property, equipment, and securities.
6. Financing Activities: Reflect changes in the company’s capital structure.
   • These activities involve raising funds through debt, issuing shares, or repaying borrowings.
   • Changes in owners’ capital and preference share capital are also included.
7. Definition of Cash and Cash Equivalents:
   • Cash includes cash in hand and demand deposits with banks.
   • Cash equivalents refer to short-term, highly liquid investments that can be quickly converted into cash with minimal risk of value fluctuation.
     Examples include marketable securities, money market instruments, commercial paper, treasury bills, and short-term government bonds with maturities of three months or less.
8. The cash flow statement helps businesses and investors by providing clear insights into cash generation and utilization, enabling better financial planning and decision-making.